Have You Heard About Custodial Accounts? Here’s The Definition
Brought to you by: Breez DeGuzman
Many people have heard about trust funds and custodial accounts. But what is the definition of a custodial account? Why are they an option that parents or grandparents may want to consider for their own children?
In its simplest terms, a custodial account is any account which is created for the benefit of a minor. This means you can make investments on your child’s behalf. You can also transfer property you already own to that child. You can open accounts (whether at a bank, brokerage firm, insurance company, or mutual fund company) in your child’s name and have it managed for them.
You choose who will act as the custodian of the account. This could be you or another adult you feel is financially savvy and who is trustworthy to manage the account. It could also be a financial institution.
You choose when the child reaches the age of majority where they are able to access the funds in the custodial account. This age is usually set at either 18, 21, or 25 years of age. Factors that determine this are the state in which you live and which type of account chosen. “Majority” is the age at which the child has the legal right to control the account and use the assets as they see fit.
There is one thing to consider before choosing this option as a means to reduce your own tax liability. If you have these assets in the child’s name, it may limit the amount of financial aid your child qualifies for when they decide to go to college.
There are two major tax rulings concerning custodial accounts: Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA). Under these rulings, earnings or interest up to $800 are tax-free for children under the age of 14. Amounts over $800 but less than $1,600 are taxed at the child’s rate. Anything over $1,600 is taxed at the parent’s tax rate. Once the child turns 14, earnings and interest will be taxed at the child’s rate, which is considerably less than what a parent would pay.
In some cases the custodial account may be set up to support a minor child under the UTMA. This means the custodian may use funds from the custodial account to pay for things benefiting the child. One such case may be a grandparent setting up a custodial account for a special needs child’s daily living as long as a parent or guardian doesn’t avoid using their own funds to support the child.
You’ll want to talk to a professional financial counselor or lawyer before setting up a custodial account. This will ensure you understand the definition of a custodial account, what benefits it has, and any legal obligations regarding this type of account. They will also be able to advise you on the particulars for setting up the account, the best majority age, and any limitations to the account.
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Tags: Child, Custodial Account, Parent
